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Friday, July 01, 2011

It was really easy getting that mortgage in Hungary, and the best of all, denominated in Swiss Francs, so the interest rate was low. Such a great plan, if it wasn’t for that currency risk. Ordinary people don’t think in such terms, and definitely did not hedge that exposure. With the ever increasing strength in the Swiss Franc, people with mortgages in Swiss Francs are starting to feel the currency effect big time. Since such a big proportion of the mortgages are taken out in non domestic currencies, people are squeezed. Could the Swiss Franc increase the debt repayments of the mortgages, and ultimately cause huge defaults in these countries?

GRAPH: Exotic Currency risk by retail business of Austrian banks. Austrian banks are most exposed to forex loans in the Czech Republic and Romania. Chart courtesy Stratfor.

Historically low interest rates on loans in Swiss francs have led consumers in major Central European countries such as Poland, Slovakia, Hungary and the Czech Republic to acquire substantial loans, particularly mortgages, in francs. Currently, 53 percent of outstanding mortgages in Poland and about 60 percent of those in Hungary are denominated in francs.
The franc’s perceived stability amid growing eurozone troubles has strengthened it considerably in comparison to the euro and Central European currencies. This is not only worrisome to the consumers in the countries with significant franc-denominated debt, who now struggle to service their increasing debt load, but also for financial institutions that hold significant assets in Central Europe, such as that of Austria.
While new homeowners in Poland and Hungary have shied away from franc-denominated loans since the franc’s strengthening in the wake of the beginnings of the eurozone sovereign debt crisis in early 2010, the franc has traditionally been considered a stable currency with low associated interest rates and therefore a good alternative to the euro. The majority of Polish and Hungarian mortgage purchasers before 2008 took out their loans in francs at a time when, due to the economic dynamism of the emerging Polish and Hungarian economies, the zloty and forint were relatively strong in relation to the Swiss franc. The franc traded for 160 forints before the crisis; it currently trades for 224, a 40 percent increase. Similarly, the franc traded for 2.1 zlotys in July 2008 before jumping 57 percent to currently trade at 3.3. Moreover, the fluctuation in the zloty or forint value of the Swiss-denominated loan proportionally increases the debt repayment value. The compulsory nature of making a mortgage payment (the failure to pay one’s mortgage will eventually result in losing one’s home) means that debtors are unlikely to default despite the increase in monthly mortgage payment value. However, debtors are also likely to drastically cut all other spending when faced with the risk of default, thus undercutting domestic consumption — a major driver of the Polish economy in particular.

The situation is not necessarily as alarming as some reports from Poland and Hungary claim. Central European governments have begun implementing stabilization measures to reduce the risk to mortgage owners. The Hungarian parliament approved a legislative package June 10 that included fixing the exchange rate on franc-denominated mortgage repayments at 180 forints. Hungary is also considering implementing a program that would buy back a defaulting property and take in its owners as tenants. Poland has thus far taken a passive role on the issue but has declared itself willing to intervene should mortgage defaults become imminent. Moreover, Switzerland itself has an incentive to devalue its currency, mainly to ensure that its large export sector remains competitive. To a certain extent, the Swiss government can mitigate the rise of the franc by purchasing foreign currency, particularly euros, driving down the demand for francs. The problem is that Switzerland has already been undertaking such an effort since the start of the eurozone crisis and yet the franc has still appreciated considerably.

However, a major economic event in the eurozone — such as a Greek default, Spanish banking problems, or the brewing political crises in Italy and Spain — could cause the franc to skyrocket in relation to both the euro and currencies such as the zloty and the forint. Such an increase could be so large that even the Hungarian and Polish governments would be unable to avoid massive domestic defaults on mortgages and Switzerland would be powerless to offset its strengthening currency. Homeowners with mortgages denominated in Swiss francs would find themselves unable to repay the value of the appreciated loan in their domestic currency and would be forced to default.
This certainly would not bode well for Europe, especially Austria. The 2008 financial crisis started in Europe when the collapse of Lehman Brothers triggered a massive capital flight away from Central Europe, and a mortgage crisis in Hungary or Poland could potentially replicate these triggers, leading to contagion across the Continent.Austria, particularly susceptible to contagion emanating from Central Europe, could act as the gateway for the crisis into the eurozone. The Austrian financial sector would have to incur these losses, potentially forcing Vienna to bail out its banks, focusing the markets and investors on Austria itself.

4
comments

Anonymous
said...

Historically low interest rates on loans in Swiss francs have led consumers in major Central European countries such as Poland, Slovakia, Hungary and the Czech Republic to acquire substantial loans, particularly mortgages, in francs.

You should have done a bit more research. While the above is true for Poland and especially Hungary, it's completely false in the case of Czech Republic and Slovakia.

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About Me

I am an INDEPENDENT Certified Financial Analyst who worked as a financial journalist for 15+ years and now evaluate global market trends. Analyzing financial and political news permanently I want to share my insight with those who understand that we are in an era of global redistribution of wealth. The US-European centric approach does not work anymore. 6 billion people in the developing countries now demand their fair share of the world's resources.
Having worked many years for a leading newswire I have learned to understand the fatal concept of ever expanding credit by heart. If you want to learn about the future of the economy, study history.